An environmental, social, and governance rating that overlooks the imminent likelihood of bankruptcy is worthless.
The electric vehicle maker, Fisker, Inc. declared bankruptcy last week, representing the loss of roughly a billion dollars of investor capital. Yet only a month ago, Sustainalytics gave Fisker a “Medium Risk” ESG rating, the same as Tesla, and suggested that Fisker was average for its industry. Sustainalytics seemed to miss the most important sustainability issue of all: the sustainability of the company itself.
And they are not the only ESG analytics firm selling flimsy ESG ratings.
These inconsistent ESG ratings prove the incoherence of the entire ESG model. Weighting ESG scores involves subjective matters of opinion. In 2021, for example, MSCI rated Coca-Cola “AAA” in their ESG scoring but they rated PepsiCo “AA.” Sustainalytics, on the other hand, gave PepsiCo a low-risk score of 16.0 while they gave Coca-Cola a medium-risk score of 22.5, all based on ESG factors! These companies should be an easy apples-to-apples comparison.
Investors, consumers, and businesses should ask what they are being sold under the ESG label. Less emissions? More diversity? More reporting? Higher wages? Less pollution? No one really knows — and that’s the way environmental and social activists and government regulators want it.
As one scholar notes, “ESG means very different things to different people. Some advocates want to advance specific environmental or labor policy outcomes. Some are individual investors who want a competitive rate of return but want to minimize their carbon footprint. Others are professionals looking to sell ESG-themed financial products and consulting services.”
Many studies find that implementing ESG does not reduce risk, improve corporate behavior, or yield better financial returns. Nor do investment funds labeled “ESG” correlate with better stakeholder outcomes as measured by violations of health, safety, and other regulations or with a smaller carbon footprint. Instead, researchers from Columbia and the London School of Economics show high ESG scores correlate with “the existence and quantity of voluntary disclosure … but not with the actual content of such disclosures.”
If anything, significant ESG investment seems only to amount to virtue-signaling support for the Left’s pet causes rather than substantive behavioral change. The portfolios of institutional investors committing to ESG by signing on to the recent U.N. Principles for Responsible Investing, or PRI, initiative, for instance, do not have higher ESG scores than the portfolios of institutional investors who did not sign the PRI initiative. In fact, institutional investors who signed the PRI initiative but did not report any effort to comply had significantly lower ESG scores in their portfolios than nonsignatories.
ESG ratings also tend to turn a blind eye to certain governance or environmental “problems” in companies that have the right diversity, equity, and inclusion stances and include favorable language on other ESG issues.
Corporate governance at Meta and Alphabet, for example, can hardly be called independent or accountable. At Alphabet, Larry Page and Sergei Brin have most of the voting rights even though they own less than 12% of the company. For Meta, Mark Zuckerberg has more than half the voting rights but owns less than 15% of the company.
And consider how in May 2022, Exxon Mobile was scored more favorably and included in the S&P 500 ESG Index, while Tesla, the pioneering EV company, was dropped from the index. Tesla was penalized for lacking an explicit low-carbon strategy document. Tesla clearly outperforms Exxon Mobil when it comes to greenhouse gas emissions. Yet the company was excluded from an ESG index for not checking the right boxes and for subjective evaluations of other “risk factors.” People investing in ESG-labeled funds because they care about climate change would be shocked to see Exxon Mobil in their portfolio instead of Tesla.
Investors should be wary of ESG ratings that can involve any mix of factors which makes it easier for these activists and regulators to impose their agendas on the rest of us. In fact, ESG should stand for “Everything Seems Good — trust us.”
But investors can’t trust these ratings. As the case of Fisker shows, ESG ratings did not help investors avoid a company at high risk of bankruptcy. If ESG ratings could miss the imminent bankruptcy of Fisker, they can miss other important issues.
No one who cares about their investments should want government regulators mandating the use of ESG ratings or ESG practices. Of course, if you have money to burn, go ahead. You’ll only be creating more greenhouse gas emissions.
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Paul Mueller is a senior research fellow at the American Institute for Economic Research.
